What are my chances for approval on a loan modification?
This is one of the most common questions I’m asked by homeowners. There are several factors that go into answering this question. The most important calculation that will determine your chances at modification approval is the front-end ratio.
As part of the modification process, the bank will ask you to send in income documentation and a list of household expenses. This documentation will be used by the bank to calculate your front-end ratio, which is a crucial part of the approval process.
Your front end ratio is the ratio of your monthly mortgage payment to your overall household income. Here is an example of how to calculate your front-end ratio:
Your monthly household income is $6,000 and your monthly mortgage payment is $1,000. You divide $1,000 / $6,000 and you get .17. Thus, your front-end ratio is 17%.
What this number means is that your mortgage payment only takes up 17% of your monthly income. This is considered a low front-end ratio and gives you a good chance at approval. A low front-end ratio indicates to the lender that there is plenty of remaining money each month for you to pay your other bills. A 17% front-end ratio would indicate to the bank that the chances of you defaulting on the mortgage again are low - you look like a good candidate for a modification. The bank will view you as financially stable, able to pay your bills and have some money set aside for emergency expenses.
Conversely, if your monthly household income is $6,000 and your monthly mortgage payment is $3,400, your front-end ratio would be 57%. This would be considered a high front-end ratio and may hurt your chances of approval. This number indicates that your mortgage payment is eating up over half of your monthly income. The bank would view you as a risk because there doesn’t seem to be a lot of income left over after you make your mortgage payment to pay your other bills. In the bank’s opinion, the risk of you defaulting again is high.
The general rule is - banks want to see your front-end ratio around 35%. Servicing guidelines have determined that it is reasonable and stable for someone to have a monthly mortgage payment that is 35% of their monthly income.
So, before you send in your application, do the math. Divide your original monthly mortgage payment (before you defaulted) by the amount of monthly income you’re bringing in. If the ratio is close to 35%, this is good. If the number comes out much higher than 35%, you run the risk of being denied.
If you have a high front-end ratio (over 55%) and you are determined to keep the home, below are two things you can do to help your ratio:
Please note that a one-time windfall of money will not improve your front-end ratio. Some people think that if they sell something valuable or get an inheritance and can make a big deposit into their bank account, this will help. Unfortunately, it doesn’t help because the bank is looking to see that you will be stable over a long period of time. Perhaps if there is a way for you to structure the windfall as on-going payments, like lottery winners do where they take 20 years of payments rather than one lump sum, you can get the bank to recognize the windfall as ongoing income.
In sum, if your front-end ratio is 35% or under, this is good. If your front-end ratio is high (over 55%), it may be tough to get approved.
More importantly than whether you can get approved by the bank is using the front-end ratio to decide whether staying in your home is actually a good financial decision for you personally.
If adding a contributor’s income or working more are not options for you and your front-end ratio is high, this is likely a good indicator that even if the bank were to allow you to resume making your regular payments, this probably isn’t a smart financial decision for you.
While I know it’s extremely tough to consider leaving your home, you don’t want to keep your home at the expense of saving for retirement, having money saved for medical emergencies, and quality of life things like going out to eat or seeing a movie.
I have worked with many clients who, once seeing their front-end ratio, realize that it is likely not in their best interest to continue fighting to stay in the home. This ratio helps you decide whether it’s a smart decision to stay just as much as it helps the bank decide whether you can afford to stay.
Sometimes, fighting to stay is stressful and making a mortgage payment that eats up most of your monthly income decreases happiness and increases stress. If you have a high front-end ratio and no real way to get the ratio down, you may want to consider looking at some other options to avoid foreclosure that involve removing yourself from the home so you can free up more of your money and increase your quality of life.
If you are a Washington state homeowner, and you have any questions about your front-end ratio or your loan modification, don’t hesitate to give me a call at (425) 654-1674. There is no charge for the consultation.